Can I Afford a Home, Using Every Rule of Thumb I Know

As I continue on my epic journey of saving $40,000 for the house I eventually plan to buy in Halifax, Nova Scotia, I often worry if I’m being realistic about the price point I set and whether or not I’ll be able to comfortably afford my mortgage.

The “what can you afford” calculators offered by the big banks aren’t helpful because they vastly over-inflate the purchase price based on their outdated debt service ratios. (For example, Tangerine tells me I can afford a home worth $489,000. Umm no.)

At the same time, there are a bunch of age-old rules of thumb that are bandied about on the internet such as “don’t buy a home worth more than three times your income,” and but many argue that those are out of date in the hottest Canadian housing markets.

Fortunately, the Halifax housing market is not hot. In fact, it’s a buyer’s market. The average home price in this city slipped 1.2% to $304,441 this quarter. Good news for me.

Even though prices here are reasonable I’m still concerned about overextending myself with a mortgage and becoming house poor. So I’m going to run through all of the different rules of thumb for home ownership to see if I am indeed ready for the financial burden of home ownership.

Price-to-Rent Ratio

First, should I even buy a home in today’s real estate market? That’s where the price-to-rent ratio comes into play. This ratio compares the total costs of home ownership to the total cost of renting a similar property. Here’s how to calculate it:

Price-to-rent ratio = Average list price / (Average Rent x 12)

The thresholds on whether to buy or rent are as follows:

Price-to-rent ratio of 1 to 15 = much better to buy than rent

Price-to-rent ratio of 16 to 20 = typically better the rent than buy

Price-to-rent ratio of 21 or more = much better to rent than buy

So we know our list price will be $280,000. After doing some research it seems I could rent a similar property for about $1,800 all included. So the math goes:
Price-to-rent ratio: 280,000 / (1,800 x 12)
Price-to-rent ratio: 280,000 / (21,600)
Price-to-rent ratio: 12.9

The rules above say it’s better to buy than to rent.

Verdict: Pass

Don’t Buy a House More Than 3x Your Gross Income

This is one I’ve heard many times, but recently some people have argued that it should be abandoned. Personally, I think that signals a problem with our housing market, not the rule itself.

Here’s how it applies to us: my husband and I have a combined income in the range of $100,000 per year, so buying a home for $280,000 satisfies this rule.

Verdict: Pass

Housing Shouldn’t Be More Than 35% of Your Net Income

This is a metric I subscribe to pretty strictly, and I used it to find the apartment I live in now. The carrying costs of the parameters above are $1,850, which is slightly less than 35% of our net income before my freelance income, once that is factored in, it is even less.

Verdict: Pass

Your Fixed Costs Should Not Exceed 50% Of Your Net Income

I forget where I heard this one, I think from a realtor at an open house. She meant all fixed expenses, not just expenses related to home ownership.

If we bought a home for $280,000, our fixed costs would be:

$1,850 for the home

$91 for car insurance

$135 for cell phone

That’s all of our fixed expenses. We have no kids (no daycare), no debt payments and we own our car outright. Everything else is variable.

Total: $2,076 which is 40% of our net income before my freelance income.

Verdict: Pass

The Real Life Ratio

Developed and popularized by Rob Carrick, the Real Life Ratio is a spreadsheet that allows you to theorize not just if you can afford a home, but if you can afford everything else that goes along with, you know, living your life.

The real life ratio adds up your housing, daycare, debt, retirement savings and other fixed expenses and divides that amount by your monthly income. If your ratio comes out to less than 75%, you are good to go. I used our net monthly income excluding my freelance income, and my ratio came to 51%.

I really like this spreadsheet because it’s easy to add in extra amounts for daycare (even though I don’t have this expense yet) and it doesn’t let you forget about home maintenance (1% of a home’s value per year).

In fact, even if our incomes did not increase at all, and I added in $500 for daycare, bumped up my retirement contributions and started saving in an RESP, my ratio only went up to 64%, still well below the 75% threshold.

Verdict: Pass

The Rule of 90

Have you read Garth Turner’s blog The Greater Fool? I go there sometimes when I’m feeling spendy and I need someone to yell at me about how overpriced the housing market is. He makes you feel good about stuffing your money in your portfolio instead of in real estate. Kinda like having a personal trainer yell at you. Same result. Don’t read the comments though. Just don’t.

Anywho, his rule of 90 states that the net worth you have tied up in real estate should less than 90 – your age. For me, the magic number would be 90 – 27 (assuming I buy next year) = 63%.

If I bought a home for $280,000 with $35,000 down I would have $29,120 in equity (the mortgaged amount includes $5,880 in CMHC insurance). I’d also have $10,000 in my emergency fund and $22,000 saved for retirement (ish) plus another $3,000 in short-term savings for a total net worth of:

$29,120 + $10,000 + $22,000 + $3,000 = $64,120

* I don’t include my car in my net worth as it is 10 years old and not worth much.

Of that $64,120, 45% of my net worth would be in real estate.

Verdict: Pass

Based on most of these indicators, I’d be safe putting $35,000 down on a $280,000 home. Now I just need to get to my goal of $40,000 saved. Only $16,000 to go! Oph that still seems so far.

How does your housing situation stack up to these rules of thumb? Do you pass or fail? Have you heard of any other rules of thumb that I’m leaving out? I want to know!

Stay Up To Date

The rule of 90 makes me feel better about how much of my net worth is in my condo! Between my pre-payments and the value going up, it’s sitting at about 53% of my net worth right now at 27. I would ideally like to keep it around 50% or lower, which I will reach this year.

I’ve also heard that you should check that a house is affordable one one salary in case the spouses decide that one of them wants to stay home with children instead of sending them to daycare since you don’t always really know until the baby comes if someone will want to do that.

That’s a good point Leigh. At this point we will definitely be able to cover the costs of the home if either of us take parental leave, but one of us was to stay home full time, that person would need a side hustle to make ends meet. Neither of us is planning to stay home with a kid though, and we’re not even sure if we want children, so I think we’ll be ok.

Keith @ centsitiveguy.com

What a great way to share so many rules-of-thumb in one place!

I’m surprised that a PF keener like yourself is not going all the way for a 20% DP to avoid those pesky CHMC fees. An extra $16,000 saved before buying will cost you another 1+ years in time up front, but save you the $5880 in CHMC fees + the extra $1600 CHMC interest over a 15 year mortgage. I suspect that the cash flow saved by paying it off 18 months earlier won’t be much greater than the cost to rent for 18 months more up front, but you’ll likely have have ‘saved’ (not spent) over $15K in mortgage and interest costs over the 15 year period.

Of course, take this with a grain of salt. It isn’t necessarily the right decision because there is so much more to consider besides the numbers, but I sure do love to crunch out the options! Thanks for sharing. I’m eager to use these ‘rules’ to analyze my own situation!

If I was a robot with infinite patience, I might wait the extra 1-2 years and save that extra money, but I’m not a robot, I’m a person, and I’ve been ready to have a permanent home for awhile now. I’m terribly impatient, which is why I’m throwing upwards of $2k towards my savings every month – that’s certainly not healthy or sustainable.

I know it’s the classic, emotional millennial thing, but I’d really like to be a homeowner sooner rather than later. I’m not going to dive in with only 5% down or anything, but I’m not sure I have the patience to potentially wait three more years before buying.

Des @ Half Banked

Oh my gosh, SO MUCH YES to this! I was going to chime in with the Rob Carrick rule of putting down 10% and staying for 10 years, because I am in the same boat – personal finance keener, but far too impatient to add years to what is already two years out for me.

As lovely as it would be put down 20%, and even though it is feasible for me and my partner (in theory) if we waited an extra year, I think I’m more comfortable putting down between 10% and 15% and having a VERY healthy margin of savings for closing costs, renovations and general savings. To me, that’s well worth the pain of the CMHC insurance. If we put down 20%, we’d be emptying basically all of our (accessible) savings, not counting RRSP accounts, and we’d be pretty tight if major repairs came up.

I agree Des! I would absolutely prefer to have a lot of money left over for repairs and closing costs than to empty my savings completely in the name of avoiding CMHC insurance. Besides, I plan on making lump sum payments every year, so I’ll be paying off this mortgage quickly anyway.

Beth

Great roundup! I avoid bank calculators and use the ones on CMHC’s website instead — they tend to be more conservative. Someone once told me that banks will give you enough rope to hang yourself, so to speak. So it’s really up to us to do the number crunching and set limits.

Can I be nosy — does that $1850 include budgeting for maintenance and repairs? I’m curious because my friends are always telling me how “affordable” owning a home is, and then the roof needs repair or the plumbing needs fixing or an appliance dies. (Never mind all the money they put into renovating their homes). I try to think in terms of total cost of ownership, not just carrying costs.

Maintenance and upkeep would be around $2,800 per year or $233 per month. I didn’t include that in my monthly carrying costs because I’m planning to save over $1,000 per month for renovations, and the maintenance costs will be part of that.

Beth

Thanks of the reply!

I think my problem is that I finished saving up for my downpayment a few years ago and have been investing that amount instead. So when I do buy, it won’t be a matter of my transferring my downpayment monthly amount towards my home. I’ll be losing out on investments! (er… good problem to have?)

It’s a good problem to have, but I think you are running in to a problem I don’t have, which is the emotional aspect of taking all of that money out of the bank to buy a home. In my mind, my house fund is ONLY my house fund, so I won’t mind spending it, but for you, your money is invested, so there will always been a little voice telling you to just leave that money there where it will grow and grow and grow.

I’d add another for whether the market is over-heated (i.e., even if you can afford it, would you be better off renting anyway?), esp. for those readers in Toronto or Vancouver. So a simple one is the price-to-rent: if the price is more than ~200X the monthly rent (of an equivalent, apples-to-apples place), you may want to look at renting instead.

Finally, timeframe: for you it’s implicit, but a good sanity check is if you’re going to be there for a long time (~7 years is a typical rule-of-thumb I’ve heard, a decade may be better). Kind of crazy in Toronto when you hear people thinking of buying places to live in for just 2 or 3 years — but (so far) the appreciation has made up for the crazy transaction costs involved in frequent moves like that.

The price to rent ratio! Of course, how could I forget that? Perhaps I’ll add it to the original post.

As far as how long we are planning to stay, our minimum is ten years, and I’ve made that very clear to my husband that we won’t be moving within ten years so everyone is on the same page. Depending on how life treats us, we may never move (we had originally talked about eventually buying a homestead outside of the city but that idea has morphed into “tiny house on a lake” which would mean we’ll keep a residence in the city.

I can’t imagine buying a place and only keeping it two or three years!

Taylor Lee @ Yuppie Millennial

I actually pass on all of these (pleasant surprise)! That said, I feel like I’m a bit over-leveraged / have too much money tied up into my home in spite of fitting the above.

I once read another rule: Your mortgage should ideally be 2x or less your gross income. 2.5x is okay. 3x or more and you’re buying too much house. Clearly, ymmv, but I think these are pretty in line with where I will start to feel more comfortable with the amount I’ve got in my home.

Hmmm, I’d have a mortgage of about $250,000, and my husband and I make around $100,000 per year, so it looks like we’d be ok!

Lau

I actually pass these rules without knowing it.
My fiancé and I had to buy a house without having 20-35% down as expected because he was relocated in a new city for his job while we were accumulating money for our next house. With the emotionnal millenial thing, he didn’t want to rent but to buy. We found the house that we loved but only had 5% down for it, which made my frugal self really nervous. I ran the numbers way too many times just to be sure we wont make ourselves housepoor buying it. We won’t, but we’ll have to be careful about our finances and build a strong emergency fund before I can say that I feel safe. We postponed our mariage so we do not accumulate debt, will hold on our travel expenditures, etc.

It sounds like you made the necessary sacrifices to make buying with only 5% down work. Good for you for prioritizing what you can afford, and putting the rest on hold! Most people would try to do it all and end up in debt!

Lau

Yep. We also had to buy before selling where we live so it didn’t help us. We’ll be receving money from that sale later this year and I do have a rental condo that I plan to sell when my renters (excellent ones) will leave in 3-4 years. 5% cashdown was not my initial plan at all. Just seeing the insurance price that comes with the mortgage made me cringe.